The global economic recovery has begun but sustaining it will require refocusing the United States toward exports and Asia toward imports, the International Monetary Fund's chief economist said.
In an article released by the IMF on Tuesday, Olivier Blanchard also said potential economic output may be lower than it was before the financial crisis struck.
The turnaround will not be simple, Blanchard said. The crisis has left deep scars, which will affect both supply and demand for many years to come.
U.S. consumption, which accounts for about 70 percent of the U.S. economy and a large chunk of global demand, would not quickly return to pre-crisis strength as households cope with trillions of dollars in losses from the falling housing and stock markets.
He said the financial crisis had made Americans more conscious of tail risks -- events that are unlikely to occur but when they do have devastating consequences.
That means U.S. consumers are unlikely to return to their free-spending ways, and both the United States and its trading partners will have to adjust. Emerging Asian countries, especially China, must play a big role.
From the point of view of the United States, a decrease in China's current account surplus would help increase demand and sustain the U.S. recovery, he said. That would result in more U.S. imports which would help sustain world recovery.
But in order for China to boost domestic demand, it will need to provide a stronger social safety net and increase household access to credit, which will encourage its consumers to save less and spend more.
Both higher Chinese import demand and a higher (yuan) will increase U.S. net exports, he said.
TAXES MUST RISE
In the short term, Blanchard said most countries will see positive economic growth for the next few quarters, although probably too tepid to reduce unemployment, which is not expected to crest until some time next year.
Much of that growth is predicated on fiscal stimulus and inventory rebuilding, both of which will have to come to an end, and the stimulus comes at a cost to future growth.
In nearly all countries, the costs of the crisis have added to the fiscal burden, and higher taxation is inevitable, Blanchard said.
All this means that we may not go back to the old growth path, that potential output may be lower than it was before the crisis, he added.
If the rebalancing toward more U.S. exports and more Asian imports fails, the future looks far more grim.
In that case, a weak U.S. recovery would likely lead to intense political pressure to extend fiscal stimulus until private demand recovers.
If officials resist that pressure, the U.S. recovery would be very slow, he said. If they bow to the pressure, high fiscal deficits may persist, leading to doubts about debt sustainability, U.S. government bonds, and the dollar.
Under that darker scenario, the dollar may depreciate in a disorderly fashion, leading to another episode of instability and high uncertainty, which could itself derail the recovery, Blanchard warned.